City Council
MEETING DATE: 3/23/2016
TITLE:
Title
Sales Tax Sharing Agreement with Honda of the Desert
End
FROM:
Leisa Lukes, Economic Development Manager
RECOMMENDATION:
Recommendation
Staff recommends the City Council conduct a public hearing under Municipal Code Title 3, Chapter 3.46 and consider designating Honda of the Desert automobile dealership located at 68025 Kyle Road as an Approved Business; and receive comments and other evidence; and consider terms of a Sales Tax Sharing Agreement between the City and GL HOD, LLC, doing business as Honda of the Desert; and adopt a Resolution making findings and authorizing a Sales Tax Sharing Agreement between the City and GL HOD, LLC, doing business as Honda of the Desert.
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BACKGROUND:
GL HOD, LLC, (Applicant), is the owner of Honda of the Desert located in the Cathedral City Auto Center. The Applicant applied for and recently received an Administrative Design Review Permit to expand and reconstruct the Honda automobile showroom and facade to comply with Honda Motor America’s current showroom design standards. The Applicant had previously completed a significant expansion and renovation in 2013 of the dealership’s service bay area.
Cathedral City Municipal Code Chapter 3.46 provides for economic incentive payments to a qualifying retail business in order to incentivize the expansion or renovation of that business upon determination by the City Council that providing such payments would enhance the quality of the facilities, goods, and services available to the public and the City’s residents; that it would result in desirable and attractive shopping experiences for the City’s residents and visitors; and that it would increase sales tax revenue to the City. The Applicant is requesting to participate in the City’s economic incentive program to receive payments supporting the proposed showroom and façade improvements. The request does not include the previously-completed service bay improvements.
DISCUSSION:
The Applicant purchased the existing Honda dealership located in the Cathedral City Auto Center in 2008. According to the Applicant, the most current renovation of the showroom and façade occurred approximately four years prior to that purchase (to meet Honda Motor America “Generation 1” design standards). Major renovations in compliance with corporate design enhancements are generally required to be implemented every 10 years. In 2013, the Applicant invested approximately $1 million to add six bays to the internal automobile service area but did not implement corporate’s Generation 2 design upgrades then in effect. Generation 3 design criteria is now the current corporate standard. According to the Applicant, neglecting to implement more than one series of design standards would violate the sales and service agreement between the Applicant and Honda Motor America. To remain in good standing and to prevent a significant reduction in vehicle allocations received by the dealership, which could reduce overall sales for this dealership, the Applicant proposes to renovate the facility in compliance with corporate standards. The cost of these improvements, however, significantly exceeds early estimates and is in addition to the considerable investment made by the Applicant in 2013.
Renovations include expanding the dealership showroom by approximately 1,000 square feet; adding a new car delivery area on the west side of the building with a canopy cover of approximately 560 square feet; and demolishing the existing façade and constructing a new one with a tower element on the north side of the building per corporate imaging (the Project). The initial cost estimate for these renovations was $950,000. Final calculations have increased this estimate to approximately $2,500,000. Some of the increased cost is attributed to the required quality of the materials, such as ACM metal finishes rather than painted stucco; the removal and replacement of existing finishes in areas not included in the expansion to eliminate inconsistencies in material finishes throughout; and electrical, mechanical, plumbing and fire sprinkler system modifications and upgrades in compliance with current building codes. The delta between the original cost estimate presented to the Applicant by Honda Motor America and the final cost estimate is approximately $1,550,000.
The Applicant submitted a request to the City to share in a percentage of the additional sales tax to be generated upon completion of the improvements for a period of time in which to recover the gap between the cost of the improvements and the financial return on the investment.
Analysis -
The City contracted with Keyser Marston Associates, Inc. (KMA), an independent professional financial consultant, to evaluate financial data obtained from the Applicant and derived from industry standards to project the expected gap, if any, between the Applicant’s financial investment to complete the Project and projected future earnings. The Applicant was solely responsible for the cost of KMA’s analysis.
Projected sales are based on both recent sales activity specific to Honda of the Desert and market trends. While future automobile industry sales are expected to remain positive, the past several years have seen unprecedented growth and the trend is unlikely to continue at the same pace. KMA employed these factors to analyze projected taxable sales of new and used cars, parts and service to be generated by the dealership for the next 15 years.
According to KMA, automobile dealers measure maximum supportable real estate development costs in relation to achievable sales volume. The general industry standard is a targeted development cost amortized annually not to exceed 1.5 percent of annual gross sales. Automobile dealers typically calculate this annual amortized cost using an amortization factor of 10 percent per year times total development costs.
For Honda of the Desert, KMA amortized the $2,500,000 investment at 10 percent per year to determine the annual cost of the total investment or $250,000 per year. KMA then projected the annual gross sales beginning in 2016 (post-improvement year) and for each year thereafter. The annual gross sales from the 2015 base year (pre-improvement year) were then subtracted from each year’s total gross sales to determine incremental sales. The result was multiplied by the industry average of 1.5 percent to determine the gap, if any, between incremental sales and the annual amortized cost. For the first four years following the investment (2016 through 2019), there is a total projected gap of $427,000. No gap is projected beyond Year 5 (Table 1).
The Sales Tax Sharing Ordinance enables the City to enter into agreements with existing businesses that expand or otherwise improve their business resulting in greater sales tax generation that accrues to the benefit of the city, provided certain findings can be made. Only new taxes that would otherwise likely not be generated without the improvement are eligible to be shared with the operator of the business. The intent of the ordinance is to incentivize business activity. The maximum rate of sales tax sharing is 50 percent of the increment generated over the sales tax base rate for a period not to exceed 10 years for existing businesses, unless the City Council determines an increase is warranted to achieve the goals and intent of the Program. The City’s Transactions and Use Tax (TUT) is separate from, and not part of, any economic incentive payments.
The $427,000 gap estimated to result in the first four years following the improvement is projected to be recovered by the Applicant through economic incentive payments comprised of 50 percent of the sales tax increment generated during the first nine years following the improvements (Table 2). The sales tax increment is the difference between the sales tax generated upon completion of the improvements (Certificate of Occupancy) and the sales tax collected in the 2015 base year ($347,000). As shown in Table 2, only the sales tax increment would be shared. The proposed maximum period in which the economic incentive payments would be paid by the City to the Applicant is nine years. The proposed maximum amount to be paid is $427,000. The Program is performance driven; therefore, payments would cease upon totaling $427,000 or at the end of nine-year period, whichever occurs first. A total net incremental increase of $477,500 in tax revenues to the City is projected by Year 9.
The Applicant is anticipated to complete the renovations within 5 months of the effective date of the Agreement. City permits have been issued for the work to be performed and demolition is underway. The Applicant currently leases the property upon which Honda of the Desert is located. The proposed Operating Covenants require the Property Owner of the underlying property and the Applicant (Tenant) to devote the property to the intended use for a period of nine years commencing the day after the City issues the final Certificate of Occupancy for the improvements. The Operating Covenants are to be signed by both the Applicant and the Property Owner.
Summary -
The intent of the Sales Tax Sharing Ordinance is to encourage the opening, operation, and expansion of new and existing retail businesses thereby creating new sources of sales tax revenue for the City’s general fund to support public services that the City provides to its residents and businesses. Consideration regarding the extent to which the City will participate in this or other Sales Tax Sharing Programs is within the realm of policy as to the benefit the project brings to the City beyond economics.
Within the recent past, the Applicant has completed a large investment in the dealership by improving the service facility. The proposed expansion and renovation of the showroom and exterior face of the building, an additional investment estimated to cost approximately $2,500,000, will provide increased benefit to customers who are both City residents and visitors seeking to purchase an automobile or parts or to have service performed at this dealership in Cathedral City. The combined improvements will help ensure continued, long-term sales growth, particularly after the recent period of unusually high growth in auto sales. Vehicle allocations from Honda corporate could suffer if this design improvement is not implemented resulting in reduced inventory, which could lead to lost sales. Additional automobile sales may also translate into increased demand for parts and service from this same dealership - all of which would lead to increased sales tax generation and employment opportunities. The Applicant has hired United Contractors to construct the Project. United performs numerous jobs within the Coachella Valley and is projected to employ many local subcontractors, engineers and vendors during the construction project.
The expanded showroom will provide for additional new vehicle display, allowing for greater sales of vehicles and the potential to employ more sales people. The interior renovation will also provide an increased customer-friendly environment. The exterior façade enhancement will provide an overall visual benefit to the Auto Center. It is probable that as one dealership undergoes a substantial renovation, others will follow.
FISCAL IMPACT:
Automobile sales have been strong during the past several years resulting in a relatively high base amount upon which the tax increment is evaluated against. The proposed amount of sales tax increment to be shared is derived on several factors, including 1) completion of the Project and 2) increase in sales tax collected above the base amount. In order to meet the Applicant’s estimated gap projected to accrue during the first four years following completion of the Project, staff recommends capping the economic incentive payments at $427,000 for a period not to exceed nine years at 50 percent tax sharing above the base amount of $347,000. There would be a loss to the City of the additional projected sales tax revenue up to the maximum amount to be shared; however, since the increased sales tax does not presently exist, there would be no loss of existing revenue to the City and a projected gain of nearly $500,000 during the first nine years following completion of the Project.
The Tax Sharing Program is performance driven so if the maximum amount of taxes to be shared is reached prior to nine years, the Agreement would be terminated. Once the dollar cap is achieved or the maximum number of years is reached, the City will receive 100 percent of the net sales tax revenue. The Operating Covenants require the Applicant to operate the property as intended for the duration of the Agreement. The Agreement is not automatically transferrable.
ATTACHMENTS:
1. Table 1
2. Table 2
3. Resolution
4. Sales Tax Sharing Report
5. Sales Tax Sharing Agreement and Operating Covenants